Address by Director of Markets Supervision Gareth Murphy at the 2nd Annual IFIA UK Symposium

28 November 2014 Speech
Good afternoon ladies and gentlemen. I would like to thank Pat Lardner and the Irish Funds Industry Association for the invitation to address you today.

For the next twenty-five minutes, I will update you on some of the Central Bank's recent policy initiatives which are of particular relevance to the funds industry; and give my views on the main European regulatory policy developments which, no doubt, are of interest to you.

A. Recent funds policy initiatives by the Central Bank

You will be aware that the Central Bank is currently running two consultations with the funds industry: one on UCITS collateral management and the other on fund manager governance. Let me say something about each consultation.

CP84 - UCITS collateral management

The consultation on UCITS collateral management (known as CP84) arises as a result of the discrete change to ESMA's Guidelines on ETFs and Other UCITS Issues that was made last year.

This change allowed all UCITS funds (not just money market funds (MMFs)) to use reverse repo as a way of investing their portfolios in government securities (and not be subject to a 20% investment limit).

Whilst we are confident that MMFs closely monitor and, indeed, target government collateral of a certain quality, the aim of CP84 is to alert the market that the Central Bank expects other UCITS managers to proactively manage exposures to sovereign securities which have been posted as collateral (or via reverse repo). This is to minimise the risk that a shock to the creditworthiness of a sovereign could ultimately lead to credit losses for the UCITS.

The final outcome of this consultation process will provide fund managers with a clear sense of what the Central Bank's supervisors will expect to see when reviewing fund managers' collateral management processes.

CP86 - Fund manager board oversight of delegates

The Central Bank's second consultation (known as CP86) focusses on measures to ensure that the boards of fund managers are conducting appropriate oversight of delegates.

In the light of UCITS V and AIFMD, there are clearly greater regulatory requirements on fund management companies (i.e. UCITS management companies and alternative investment funds management companies (AIFMs)). Correspondingly the task of complying with fund governance requirements has increased.

In addition to the extra workload, there are also increased expectations that the fund management company will maintain sufficient control over all aspects of its operations.

In previous speeches this year, I explained that the Central Bank would look to verify, via its imminent themed supervisory work, that AIFMs, in particular, met our expectations in terms of the 4Cs: control, capacity, capability and (the management of) conflicts.

CP86 impacts a wide range of players in the funds industry: promoters, investment managers, fund directors and other service providers.

The increased regulatory burden of UCITS V and AIFMD brings both financial costs and increased regulatory and legal risk.

From the point of view of directors of fund management companies, the increased regulatory risk can be mitigated by having more resources at their disposal within the fund management company. These resources must be under the control of the board and be fully aligned with its objectives.

From the point of view of fund promoters, there is clearly some element of trade-off between the increased resources devoted to the fund management company and additional oversight by boards of delegates of the fund management company.

Various initial reactions to the Central Bank's consultation have highlighted the risk of overburdening fund management boards and stretching their oversight role. Indeed it has been argued that the demands of good fund governance are compromising good corporate governance. Lastly, some industry participants have concerns about the loosening of the Central Bank’s local director requirements.

The consultation does not close until 12 December and we are looking forward to extensive feedback. The Central Bank's final approach will be based both on the supervisory evidence uncovered from our imminent themed inspection (of fund management companies) as well as a careful consideration of the consultation responses.

Given the different types of fund management companies regulated by the Central Bank, I would anticipate that this is likely to highlight a range of issues including the need to accommodate the varied nature, scale and complexity of fund management companies authorised in Ireland.

Loan Origination by Alternative Investment Funds

Following a lengthy period of consultation and policy-consideration, the Central Bank recently launched a bespoke regime for alternative investment funds (AIFs) that seek to originate loans. This regime went live on 1 October.1  Since then, there has been considerable interest in the regime from various promoters, peer regulators and international bodies.

And, indeed, a vibrant debate is now underway amongst policy-makers in view of the need to promote reliable funding channels which can complement and possibly substitute for bank funding channels which, as we all know, are under pressure since the financial crisis.

In response to some initial queries by promoters, the Central Bank has provided additional clarifications via an FAQ2 indicating, for example, (a) that loans of different levels of seniority are allowed, (b) that equity can be held if it is part of a distressed loan work-out scenario and (c) that bonds and derivatives are acceptable for treasury management and hedging purposes.

Some promoters have questioned why multiple investment strategies are not allowed. The Central Bank believes that the substance of the lending operation is critical to the fund manager's operations and that there is the risk of diluting this by allowing multiple strategies to be operated in a single fund.

In our policy-considerations at the Central Bank, we were conscious that a bespoke regime had the potential to attract a wider range of fund investors. At present in Europe, only two countries have bespoke loan origination regimes. Three countries prohibit non-banks from lending altogether. It would appear that most other European countries allow funds to originate loans, by default, though it is not clear how much activity is going on.

Since this debate on loan origination has started, I sense an increasing appetite amongst regulators to consider a more harmonised approach. It is unclear how this debate may impact the new European Commission's regulatory agenda for capital markets or how it might interact with the European Long-Term Investment Fund Regulation (ELTIF). However, it is important that any efforts to achieve harmonisation must carefully address the three issues of investor protection, financial stability and the financing of the real economy.

B. Current European regulatory agenda for the Funds Industry

Let me make some remarks about the current European regulatory agenda insofar as it touches on the funds industry.

Money Market Funds (MMFs)

Current drafts of the EU MMF regulation do not properly deal with the issue of external support (in exceptional circumstances) by fund sponsors - be they CNAV funds or VNAV funds. So the issue of investor moral hazard does not go away.

Therefore, the risk of an investor run manifesting itself on a central bank balance sheet via a sponsor's support is still there since the sponsor is typically a bank.

My preferred solution would be an outright ban on external support altogether in order to quell the associated moral hazard. However, I can see that this may be politically unpalatable.

In this regard, the recent proposal of the European Parliament rapporteur on MMFs is a second best solution since the cumbersome procedure of requiring European Commission consent for external support in exceptional circumstances is likely to be a deterrent to fund sponsors. But I am not sure that it eliminates the issue of investor moral hazard. And I am not sure that it does not have other unintended consequences for the European Commission as the key decision-maker in a crisis.

It is worth recalling that the US Securities and Exchange Commission (SEC) amended its rules for MMFs last summer. The changes clearly focussed on those types of funds that suffered investor runs in 2008, namely, prime institutional money market funds (as opposed to MMFs invested in treasuries or retail MMFs).

And the US SEC clearly prioritised the operational issues of tax treatment and accounting treatment before mandating that prime institutional money market funds would be compelled to be VNAV funds.

Within the context of the European debate, I have heard people say that this issue is in the 'too-hard-to-fix' category. The financial crisis taught us 'first-best solutions' require a commitment to tackle 'too-hard-to-fix' and that 'second-best solutions' ultimately flatter to deceive.

Whatever the outcome of the European debate, and given the various proposals in circulation, some part of the CNAV industry is likely to be moving to VNAV, I do believe that it is important that these tax and accounting issues are addressed first and that existing CNAV investors are not operationally disadvantaged.


Many in this audience will be anticipating ESMA's Final Report regarding its advice to the European Commission on aspects of UCITS V. Considerable industry feedback was received to this consultation and there were a number of contentious issues.

First, some commentators objected to the proposed requirement that third-country delegates of depositories would have to seek independent legal advice regarding the treatment of fund assets under local insolvency laws on the basis that the cost of such advice would be excessive and that in-house legal advice would suffice.

I have to confess that I was not impressed by these arguments. Such advice is inherently specialised and unlikely to be within the normal range of in-house legal counsel. Moreover, requiring independent external advice brings the extra safeguard of a reduced potential for conflicts of interest, especially where a tough decision must be made if local law or jurisprudence changes.

Second, there was much debate as to what should be the appropriate arrangements to put in place so that a depository and a UCITS investment manager would 'act independently'.

A small minority of EU countries actually require that a UCITS should have non-affiliated depositories and investment managers. Most EU countries prefer the alternative option (which was consulted on) which requires a range of safeguards aiming to ensure that these parties act independently without a very costly re-papering exercise which would have involved UCITS having to appoint a new depository which is unaffiliated with the investment manager.

Depository Asset Segregation under AIFMD

You will be aware that ESMA has been considering the issue of asset segregation within the depository chain under AIFMD for some time. As chair of ESMA's Investment Management Standing Committee, this has been one of the most contentious issues of my tenure. The reason for this, I believe, is that there has been insufficient exploration and clarity around the costs and benefits of extra segregation of accounts at a depository and throughout the depository chain.

In effect, we need more information about the costs of extra levels of segregation and the potential benefits of this bearing in mind that this may, in fact, only become clear in the rare and unfortunate scenarios where a depository fails.

In any case, I expect that industry stakeholders will be offered the opportunity to express their views in due course. I would strongly urge you to take the opportunity to give careful consideration to the various options and to clearly highlight the cost and benefits of them.

AIFMD third-country passport

Probably the most substantial funds-related issue which ESMA will consider next year is the advice which is to be provided to the European Commission and the legislators in relation to the possible extension of the AIFM passport to third countries. ESMA launched a 'call for evidence' on aspects of this issue a few weeks ago.3

The possible extension of the third-country passport goes hand in hand with the expectation that national private placement regimes will be phased out by 2018.

You will all recall from the original negotiations on AIFMD back in 2010 that this was one of the most contentious issues in the political debates. In Europe, we are rapidly approaching the point where we will be picking up the can which was originally kicked down the road.

Article 67 of AIFMD sets out in prosaic terms the various issues which will form the basis of ESMA's advice.

I expect that the regulatory debate will focus on the issues of (a) cross-border supervision and co-operation, (b) regulatory and supervisory equivalence, (c) mutual access between the EU and third country fund markets and (d) the possibility of competitive distortion. In my opinion, some of these issues belong to trans-Atlantic trade negotiations. I am strongly of the view that ESMA's advice should focus on the technical regulatory and supervisory issues and that it should avoid attempting to resolve some of the thorny political questions which could not be resolved back in 2010.

The next wave....?

Finally, let me make a few remarks about the broader regulatory agenda now that there is a new European Parliament and now that a new European Commission has taken office.

There has been lots of speculation as to what the agenda of the new European Commission would be. The recent speech by the new Internal Markets Commissioner, Lord Hill, was instructive in setting the tone for the next five years.

I am encouraged when I hear that " is only common sense to take a step back after five busy years of legislating in crisis conditions and ask ourselves this question: have we always struck the right balance between reducing risk and encouraging growth?"4

The costs to both industry and to national regulators of the regulatory reform agenda have been substantial. We have yet to work out how this will translate into an increased cost for investors and end-users.

But the cost-benefit calculus must work. Otherwise, the regulatory agenda will lose credibility and there may be unpredictable political consequences. It is timely to take stock with this in mind and I would also hope that as part of this exercise there might be closer reflection on what 'good' and 'bad' looks like when viewed through the prism of a disciplined process of regulatory policy-formation5 as we have had many examples of both over the last five years.

Equally, we should not lose sight of the benefits of the many reforms to financial stability, market integrity and investor protection. The various rate-rigging and benchmark scandals highlight the cultural malaise which has, to a certain extent, prompted such a vigorous regulatory response. But that the overall culture in financial services left a lot to be desired, such an overwhelming regulatory response might not have been necessary.

In short, a strong culture in industry of delivering a good, honest service to the end-investor and the end-user is a better and more cost-efficient substitute for layers and layers of financial regulation.6

I also thought that it was particularly insightful that Lord Hill emphasised in his first speech that the "financial sector needs to explain more to the public what it does and how it supports the economy as a whole." This chimes with remarks I have made on many previous occasions where I have criticised industry for not engaging properly with the regulatory reform agenda and for relying too often on arguments which resist change and emphasise the costs of regulatory change instead of stressing the significant economic role which financial services plays supporting the real economy.

Lastly, I note the fine words of Lord Hill indicating a commitment "to make sure that international standards and principles are implemented consistently."

My big concern on this point is that both the European Parliament and the European Council (and their counterparts in the US and elsewhere) must share this sentiment if it is to become a reality that ultimately leads to greater consistency in regulation globally.


When the history books are written, it is likely that the financial crisis and the ensuing regulatory reform agenda will have been one of the most significant events in the financial services industry in the twenty-first century - though the ongoing revolution in information technology has the potential to eclipse these chapters. Increasingly, there is a clearer focus amongst policy-makers on the balance between the benefits and costs of regulatory change. And that is a good thing.

The Central Bank of Ireland is clear on its mandate to protect investors, safeguard financial stability and preserve market integrity. And it is mindful that a careful consideration of the regulatory cost-benefit calculus is a necessary part of our role of ensuring a safe and efficient delivery of financial services.

As the next phase of regulatory reform commences, it is important that industry plays its own constructive role responding to the various consultations and engaging in the various regulatory debates. More importantly, to maximise your impact on European legislators, I would urge you to frame your arguments in terms of how your firms are supporting the real economy.

Thank you very much.


1 CP85 Consultation on loan originating Qualifying Investor AIF

2 Central Bank Markets Update page 


4 "Capital Markets Union – finance serving the economy", Lord Jonathan Hill, Brussels, 6 November 2014 (

5 "The Spectrum of Regulatory Engagement", K Moloney and G Murphy, 2013

6 "The New Chicago School", L Lessig, 1998